Sunday, August 15, 2010

The Bottom for Housing Starts?

Warren Buffett commented on CNBC a couple months ago saying we should expect to see an up-tick in house prices in about a year, at least for regions not overproduced. Though it should be read with caution as he acknowledges he didn't appreciate the size of the housing bubble years ago and made some mistimed investments in companies like U.S. Gysum. In any case he's generally more right than wrong and current trends may actually favor his projection.

The price of housing, like all assets are governed by supply and demand so that's a good place to start when examining housing. Below is the annual figure for new housing construction from the U.S. Census

Figures in thousands

1991 1,013.9

1992 1,199.7

1993 1,287.6

1994 1,457.0

1995 1,354.1

1996 1,476.8

1997 1,474.0

1998 1,616.9

1999 1,640.9

2000 1,568.7

2001 1,602.7

2002 1,704.9

2003 1,847.7

2004 1,955.8

2005 2,068.3

2006 1,800.9

2007 1,355.0

2008 905.5

2009 554.0

2010 549.0

The steep drop off is unparalleled in the last 40 years of housing starts, but the boom was equally so. Buffett had noted that in 2005 when housing starts were about 2 million household formations, the demand side, were running about 1.2 million. More houses were being created than people could fill. Fast forward to 2008 and we're left with excess inventory resulting from foreclosures.

There still exists a large inventory of houses and even a "shadow inventory" of delinquent mortgagors that haven't been put into foreclosure by Freddie Mac and Fannie Mae. Inventory levels will need to drop to normal levels before prices can ascend. Both Buffett and Robert Shiller noted that unemployment weighs heavier on house prices than does higher interest rates. Buffett doesn't see a rise in interest rates having a significant negative impact on housing, but unemployment does remain elevated and shows little signs of abating.

So how good does Buffett feel about housing? Good enough to not sell any of his shares in U.S. Gypsum, a maker of sheet-rock. He sold shares in Johnson and Johnson, Ingersoll-Rand, and Proctor and Gamble in the past year. U.S. Gypsum is a unique investment for Buffett because it is quite commoditized and it doesn't appear to have the "moat" like many of his other investments have. The company claims to operate as the low-cost producer and they do hold patents on the name Sheetrock which they are credited with inventing. But many other drywall producers exist, Chinese firms as well.

The company recently unveiled a lightweight version of sheetrock which is about 30% lighter than present models. The company claims heavy sheetrock is the single largest concern of contractors and this new model maintains a pound for pound durability which is stronger than heavier versions. However, the company is seemingly producing more red ink than sheetrock at the moment. It has been operating at a net loss since 2008 and has mothballed facilities until demand picks up. The new lighter model is unlikely to bail them out from current trends, but it should pad earnings in future years.